41-DE-2043-Project Risk management

1. Define & explain the term Risk and uncertainty.

Definition of Risk

In the ordinary sense, the risk is the outcome of an action taken or not taken, in a particular situation which
may result in loss or gain. It is termed as a chance or loss or exposure to danger, arising out of internal or
external factors, that can be minimised through preventive measures.

In the financial glossary, the meaning of risk is not much different. It implies the uncertainty regarding the
expected returns on the investments made i.e. the probability of actual returns may not be equal to the
expected returns. Such a risk may include the probability of losing the part or whole investment. Although
the higher the risk, the higher is the expectation of returns, because investors are paid off for the additional
risk they take on their investments. The major elements of risk are defined as below:

 Systematic Risk: Interest Risk, Inflation Risk, Market Risk, etc.

 Unsystematic Risk: Business Risk and Financial Risk.

Definition of Uncertainty

By the term uncertainty, we mean the absence of certainty or something which is not known. It refers to a
situation where there is multiple alternatives resulting in a specific outcome, but the probability of the
outcome is not certain. This is because of insufficient information or knowledge about the present condition.
Hence, it is hard to define or predict the future outcome or events.

Uncertainty cannot be measured in quantitative terms through past models. Therefore, probabilities cannot
be applied to the potential outcomes, because the probabilities are unknown.

Key Differences Between Risk and Uncertainty

The difference between risk and uncertainty can be drawn clearly on the following grounds:

1. The risk is defined as the situation of winning or losing something worthy. Uncertainty is a condition
where there is no knowledge about the future events.

2. Risk can be measured and quantified, through theoretical models. Conversely, it is not possible to
measure uncertainty in quantitative terms, as the future events are unpredictable.

3. The potential outcomes are known in risk, whereas in the case of uncertainty, the outcomes are
unknown.

4. Risk can be controlled, if proper measures are taken to control it. On the other hand, uncertainty is
beyond the control of the person or enterprise, as the future is uncertain.

5. Minimization of risk can be done, by taking necessary precautions. As opposed to the uncertainty
that cannot be minimised.

6. In risk, probabilities are assigned to a set of circumstances which is not possible in case of
uncertainty.

Conclusion
There is an old saying, “No risk, No gain”, so if any enterprise wants to survive in the long run, it has to take
calculated risks where the probability of loss is comparatively less, and the chances of gains are higher.
Uncertainty is inherent in every business which cannot be avoided, and the business person has no idea
about what will happen next, i.e. the outcome is unknown.

3. Examine the nature of financial statement analysis.

Financial Statements Analysis

The purpose of financial statement analysis is to examine past and current financial data so that a company's
performance and financial position can be evaluated and future risks and potential can be
estimated. Financial statement analysis can yield valuable information about trends and relationships, the
quality of a company's earnings, and the strengths and weaknesses of its financial position.
Financial statement analysis begins with establishing the objective(s) of the analysis. After the objective of
the analysis is established, the data is accumulated from the financial statements and from other
sources. The results of the analysis are summarized and interpreted. Conclusions are reached and a report is
made to the person(s) for whom the analysis was undertaken.
To evaluate financial statements, a person must:
1. be acquainted with business practices,
2. understand the purpose, nature, and limitations of accounting,
3. be familiar with the terminology of business and accounting, and
4. be acquainted with the tools of financial statement analysis.
Financial analysis of a company should include an examination of the financial statements of the company,
including notes to the financial statements, and the auditor's report. The auditor's report will state whether
the financial statements have been audited in accordance with generally accepted auditing standards. The
report also indicates whether the statements fairly present the company's financial position, results of
operations, and changes in financial position in accordance with generally accepted accounting
principles. Notes to the financial statements are often more meaningful than the data found within the body
of the statements. The notes explain the accounting policies of the company and usually provide detailed
explanations of how those policies were applied along with supporting details. Analysts often compare the
financial statements of one company with other companies in the same industry and with the industry in
which the company operates as well as with prior year statements of the company being analyzed.
Comparative financial statements provide analysts with significant information about trends and
relationships over two or more years. Comparative statements are more significant for evaluating a
company than are single-year statements. Financial statement RATIOS are additional tools for analyzing
financial statements. Financial ratios establish relationships between various items appearing on financial
statements. Ratios can be classified as follows:
1. Liquidity ratios. Measure the ability of the enterprise to pay its debts as they mature.
2. Activity (or turnover) ratios. Measure how effectively the enterprise is using its assets.
3. Profitability ratios. Measure management's success in generating returns for those who provide
capital to the enterprise.
4. Coverage ratios. Measure the protection for long-term creditors and investors.
Horizontal analysis and vertical analysis of financial statements are additional techniques that can be used
effectively when evaluating a company. Horizontal analysis spotlights trends and establishes relationships
between items that appear on the same row of a comparative statement thereby disclosing changes on items
in financial statements over time. Vertical analysis involves the conversion of items appearing in statement
columns into terms of percentages of a base figure to show the relative significance of the items and to
facilitate comparisons. For example, individual items appearing on the income statement can be expressed
as percentages of sales. On the balance sheet, individual assets can be expressed as a percentage of total
assets. Liabilities and owners' equity accounts can be expressed in terms of their relationship to total
liabilities and owners' equity.
Financial statement analysis has its limitations. Statements represent the past and do not necessarily predict
the future. However, financial statement analysis can provide clues or suggest a need for further
investigation. What is found on financial statements is the product of accounting conventions and
procedures (LIFO or FIFO inventory; straight-line or accelerated depreciation) that sometimes distort the
economic reality or substance or the underlying situation. Financial statements say little directly about
changes in markets, the business cycle, technological developments, laws and regulations, management
personnel, price-level changes, and other critical analytical concerns.
4. What are civil liabilities of business house? Explain?

Civil liability is the obligation to compensate for bodily injury or tangible or intangible damage that may be
caused to a third party by the company’s belongings or staff, over the course of work completed.

There are a number of situations in which the company’s liability may be invoked.

Civil liability laws dictate all rules that define the conditions under which victims of an accident can obtain
compensation from the responsible party.

It implies that:
 Damage has been caused,
 Something caused this damage,
 There is a causal link between the two.

The party claiming compensation must always prove each of the three conditions.

Liability is divided into two sections: contract liability and tort/quasi-tort liability.

Contract liability is when failure to fulfill a contract causes damage.

Thus, contract liability is when there is a breach of contract (failure to fulfill contract or failure to fulfill
contract to standard), that causes damage and a causal link is established between the two.

Tort/quasi-tort liability is when professional negligence causes damage to a third party who is not under
contract.
The result can be civil liability:
 On the grounds of having personally caused the damage (articles 1382 and 1383 of the Civil Code),
 On the grounds of events (article1384 clause 1 of the Civil Code),
 On the grounds of other people (article 1384 and following of the Civil Code),
 On the grounds of failure to fulfill a contractual obligation, whether the work is not completed to
standard or not (articles 1147 and 1137 of the Civil Code).

5. "Insurance is an effective tool of risk retention" Discuss.

Risk Retention
It is nothing than presuming that we are going to incur certain losses on a particular issue but at the same
time are not willing to transfer such risks to another party.

For example in an individual case a persons decides to bear all the losses caused to his property by himself
and never cares to get his property insured means all the risk shall be retrained by that particular individual
and in case of any eventuality he shall only be paying from his own pocket for the losses caused to his
property.

And in case of a corporation or a company engaged in construction works, if it is decided to pay to the
accidental expenses of its employees instead of entering into an agreement with any insurance company to
compensate the expenses.

In such a case the corporation or the company concerned have decided to bear the cost themselves
instead of transferring it to any insurance company and are also willing to retain the loss.( IN SHORT THE
LOSSES WHICH ARE BORN BY ANY INDIVIDUAL OR A COMPANY OUT OF HIS/IT OWN
POCKET IS CALLED RETENTION OF RISK).

Types of Risk Retention:

Risk of any type is always an action of uncertainty. Either when should be willing to accept such risk
knowingly and voluntary. When such a decision is taken the risk is known as voluntary risk with considered
and conscious decision where certain level of risk is retained willingly rather than transferring it to another
party (Say insurance company) at a cost (say premium). Such type of risks are sometimes imposed by the
insurers also up to certain level.

A situation also arises when some risk occurs due lack of pre identification of the risk. Such type of risk are
known as non-voluntary risk because these occur due failure of identification of risk before hand. In such
circumstances the risk has to be retained and met out of within own sources on the happening of eventuality
of the occurrence of the event.

In other words the retention of risk means one is liable to bear the losses himself up to the amount retained.
May be it is done to keep the cost of insurance premium at the minimum level.

In case of companies the risk retention is either by not having insurance that covers a particular eventuality
or in the form of deductibles. They may also not be having insurance for certain occurrence. But generally
most of the companies do maintain a contingency fund with a big role of retaining the risks.

Basically the more risk a company retains, the more needs to be set aside in the contingency funds. But it is
not the solution of covering the risks. At last most of the companies by themselves or through the services of
any consultant take the shelter of one or the other insurance company to transfer their risk. However the
quantum of risk can be decided to be retained on the advise of such consultant which any company is ready
to bear itself.

Such decisions are based on mathematical calculations against the rate of retaining the risk and payment of
premium to insurance companies. In India there is an insurance scheme to compensate banks for loss on
account of bad debts known as Deposit insurance and credit guarantee scheme which provides insurance to
banks against unrecoverable loans.

But many banks decided to not to seek insurance cover under this scheme only because the amount of
premium paid was much higher than the amount of insurance cover received . As such these banks decided
to retain the risk instead of seeking the insurance cover.
 7 How is risk identified? Explain briefly.

10. How far risk managers duties relevant to business? Discuss.

 The role of the Risk Manager

 Provide a methodology to identify and analyze the financial impact of loss to the organization, employees,
the public, and the environment.
 Examine the use of realistic and cost-effective opportunities to balance retention programs with commercial
insurance.
 Prepare risk management and insurance budgets and allocate claim costs and premiums to departments and
divisions.
 Provide for the establishment and maintenance of records including insurance policies, claim and loss
experience.
 Assist in the review of major contracts, proposed facilities, and/or new program activities for loss and
insurance implications.
 In cooperation with General Counsel, maintain control over the claims process to assure that claims are
being settled fairly, consistently, and in the best interest of the entity.

Role of other managers

The Risk Manager cannot be successful without the assistance of other groups within the organization. At
Marquette University, cooperation from departments' and divisions' staff is essential.

 Other managers must provide information necessary for the risk manager to review and identify loss
exposures.
 Supervisors must be aware of their role in the prevention of loss and be accountable to follow procedures,
attend risk control meetings, and, when appropriate, provide any recommended training.

11. Examine the nature and scope of safety audit.

Audit is a systematic and, wherever possible, independent examination to determine whether activities and
related results conform to planned arrangements and whether these arrangements are implemented
effectively and are suitable to achieve the organization's policy and objectives.

The health and safety management audit our members adopted is a structured process of collecting
independent information on the efficiency, effectiveness and reliability of the total H&S management
system and drawing up plans for corrective action.

Auditing examines each stages in the H&S management system by measuring compliance with the controls
the organisation has developed, with the ultimate aim of assessing their effectiveness and their validity for
the future.

H&S Management audits look into the following areas:

1. Does the company have adequate procedures for identifying specific H&S requirements
which apply to its undertakings?
2. Are the procedures followed and are responsibilities set out clearly and understood?
3. Does the company's H&S policy documentation include adequate procedures for identifying
hazards which exists at the workplace, and for assessing regularly the risks to employees and
others affected by the workplace and workplace activities in order to identify the measures
needed to avoid their exposure to risks of harm?
4. Are adequate risk assessment procedures also set out for hazards of products and /or services
supplied by the company in order to identify the measures needed to avoid risks of harm to
people such as distributors, customers, end-users and members of the public?
5. Are the procedures in 3. and 4. followed, and are responsibilities set out clearly and
understood?
 6. Does the company have adequate procedures for setting, reviewing and revising as necessary
its health and safety standards for meeting specific H&S requirements and for meeting its
general duties to protect employees and others form risks identified in the company's risk
assessments?
7. Do the procedures for setting company standards include the identification of measurable
targets which can be audited to monitor the level of compliance with company standards?
8. Are the procedures in 5. and 6. followed and are responsibilities set out clearly and
understood?
9. Does the company have adequate procedures for planning, implementing, controlling,
monitoring and reviewing the measures identified in 3. and 4. ?
10. Does the company have adequate procedures for carrying out H&S audits to check that the
procedures in 9. are followed and that the measures in 3. and 4. are effective?

12. Summarise the various risk exposer loses with an illustration.

Risk Exposure is a simple calculation that gives a numeric value to a risk, enabling different risks to be
compared.

Risk Exposure of any given risk = Probability of risk occurring x total loss if risk occurs

A limitation of this calculation is that it will give the same scores to high-probability/low loss risks and low-
probability/high loss risks. If you are concerned with these differences, a Risk Matrix may be a better way of
evaluating risks.

Property Loss Exposure

· Replacement or repair of vehicles, buildings, machinery, raw materials, goods in process and finished
goods subject to physical and human perils on the premises or in transit.
· Shutdown or slowdown of operations because of property losses.
· Accidental breakdown of electrical or mechanical equipment, air conditioning, refrigeration, boilers,
pressure vessels, and production and processing equipment

TYPES
Liability Losses
_ Liability for bodily injury or property damage to 1) third parties because of defective products, 2) visitors
because of hazards on premises, and 3) others because of your operations.
_ Legal responsibility due to the workers’ compensation laws for bodily injuries to
employees.
Personal Losses
_ Automobile accidents.
_ Losses because of the death or disability of employees.
_ Losses to families of employees because of death, poor health or retirement of
employees.
Net Income Loss Exposure
Types of Loss Exposures within the province of risk management include:
· Property - Real & Personnel, Tangible & Intangible
· Net Income - Reduction in Revenue or Increase in Expense; can be due to loss of
Property (yours or suppliers, or customers) or loss due to Civil or Statutory fines and judgments, or by loss
of Key Personnel
· Liability - Civil and Statutory (Torts, Statutory Workers Compensation, EPA and other
Administrative laws)
· Personnel - Through Death, Disability, or Retirement Key Personnel or catastrophic loss to many
employees
Risk management strategies involve many concepts. Some of them include the following concerns:

Elements of Loss Expense

_ Actual damages to physical assets to repair or replace.
_ Increase in expenses or reduction of revenue due to loss.
_ Cost of investigation, legal fees, fines and awarded judgments.
_ Loss of worker productivity and adverse publicity and public opinion.
_ Higher potential insurance premiums.
_ Payments made due to the death, disability or resignation of employees.

13. Critically Examine the risk management techniques in brief.

A Business risk comes in a variety of tangible and intangible forms over the course of the business life
cycle. Some risks occur during the ordinary course of business operations, while others are due to
extraordinary circumstances that are not easily identified. Regardless of a company's business model,
industry or level of earnings, business risks must be identified as a strategic aspect of business planning.
Once risks are identified, companies take the appropriate steps to manage them to protect their business
assets. The most common types of risk management implemented in business include avoidance, mitigation,
transfer and acceptance.

Avoidance of Risk
The easiest way for a business to manage its identified risk is to avoid it altogether. In its most common
form, avoidance takes place when a business refuses to engage in activities known or perceived to carry risk
of any kind. For instance, a business could forgo purchasing a building for a new retail location as the risk of
the location not generating enough revenue to cover the cost of the building is high. Similarly, a hospital or
small medical practice may avoid performing certain procedures known to carry a high degree of risk to the
well-being of the patient. Although avoiding risk is a simple method to manage potential threats to a
business, the strategy also results in lost revenue potential.

Risk Mitigation
Businesses can also choose to manage risk through mitigation or reduction. Mitigating business risk is meant
to lessen any negative consequence or impact of specific, known risks, and is most often used when business
risks are unavoidable. For example, an automaker mitigates the risk of recalling a certain model by
performing research and detailed analysis of the potential costs of such a recall. If the capital required to pay
buyers for losses incurred through a faulty vehicle is less than the total cost of the recall, the automaker may
choose to not issue a recall. Similarly, software companies mitigate the risk of a new program not
functioning correctly by releasing the product in stages. The risk of capital waste can be reduced through
this type of strategy, but a degree of risk remains.

Transfer of Risk
In some instances, businesses choose to transfer risk away from the organization. Risk transfer typically
takes place by paying a premium to an insurance company in exchange for protection against substantial
financial loss. For example, property insurance can be used to protect a company from the financial losses
incurred when damage to a building or other facility takes place. Similarly, professionals in the financial
services industry can purchase errors and omissions insurance to protect them from lawsuits brought by
customers or clients claiming they received poor or erroneous advice.

Risk Acceptance
Risk management can also be implemented through the acceptance of risk. Companies retain a certain level
of risk brought on by specific projects or expansion if the anticipated profit generated from the business
activity is far greater than its potential risk. For example, pharmaceutical companies often utilize risk
retention or acceptance when developing a new drug. The cost of research and development does not
outweigh the potential for revenue generated from the sale of the new drug, so the risk is deemed acceptable.